Economic commentary from David Oser, formerly chief economist at ShoreBank

August 28, 2011

Two for One: Ben Bernanke’s Jackson Hole Speech

Over the years I have read many speeches—and have been privileged to attend a few—given by high officials of the Federal Reserve System. Despite the differing economic circumstances and economic views expressed, what's most remarkable is how similar the speeches are. In the first place, they are always read verbatim from a prepared text. The speakers understand the power their words have to move markets; they don't want to be blamed for a slip of the tongue or an off the cuff remark. Second, the officials realize they are public servants, so even when the speeches touch on technical subjects, they are accessible to any reasonably intelligent person. Third and most interestingly, the speeches are rarely about especially technical subjects; instead they tend to be general overviews, either of economic conditions as a whole or some specific aspect of the economy.

In consequence, the speeches can sound bland and even formulaic, leading veteran commentators to gloss over most of the content, in favor of focusing on one or two sentences or even words that seem to be new or, better yet, controversial. This is natural, but it's a mistake. These speeches are very well thought out for their overall effect. Those given in especially important venues, like the one Fed Chairman Ben Bernanke gave at a conference of top economists at Jackson Hole, Wyoming, last week, are worth a more comprehensive review. This speech was divided into two parts, "Near-Term Prospects for the Economy and Policy" and "Economic Policy and Longer-Term Growth in the United States." Economic commentary has been almost entirely taken up with the second part, though the first part is both more interesting and more revealing about our current economic problems.

In this initial part of his speech, Bernanke admits that the Fed, along with the rest of the country, has been dissatisfied with the economic recovery. In fact, the Fed, despite its hundreds of economists, was taken by surprise by the most recent data. "We have learned that the recession was even deeper and the recovery even weaker than we had thought." Not only is economic output still less than it was before the recession, but growth rates remain "insufficient to achieve sustained reductions in unemployment, which has recently been fluctuating a bit above nine percent."

Next, he explains the virtuous cycle of the typical recovery: Pent-up demand leads to increased output, which leads to more hiring, which creates more disposable income and greater willingness to borrow, which leads to more demand, and on and on. The cycle has not developed in this recovery because of "both a very deep slump in the housing market and a historic financial crisis."

The two are intimately tied together. Demand for home ownership and almost constantly increasing home values have been the main drivers of recovery from every previous recession since the Great Depression. The demand was fueled by mortgage credit, which consistently became easier to obtain. Required down payments dropped from 20% to 10% to 3% and finally to nothing at all. Creditworthiness was measured on a similarly downward sloping trajectory. The psychology that ruled for several decades was that home values always went up. If a borrower couldn't pay the mortgage, the property could be sold quickly and the lender usually got out whole. But now the psychology has completely turned around. Housing markets in virtually every part of the country are shackled by "tight credit conditions for builders and potential homebuyers, and ongoing concerns by both borrowers and lenders about continued house price declines."

We should stop a moment and consider the words "tight credit conditions." Since 2007, the Federal Reserve has been trying to ease credit conditions. They have set the target rate for overnight borrowing between banks at 0-0.25%. They have poured trillions of dollars into the economy by buying securities, all in an effort to get consumers and businesses to save less while borrowing and spending more. It hasn't worked for a very simple reason. The cost of credit is cheap, alright; mortgage rates are at all-time lows. But credit itself is far from easy. The financial crisis led to new and burdensome regulations that make getting a mortgage extremely difficult. Mortgage bankers are not even allowed to speak to appraisers—they have to go through a middleman—and the required documentation continues to increase. It's all done in the name of protecting the consumer, but the result is that record numbers of contracts to buy houses are falling through. Both new and existing home sales remain stuck at historically low levels.

Chairman Bernanke has said many times that the Fed has "a range of tools that could be used to provide additional monetary stimulus." That may be so, but the tools used so far, which are the standard, long-established methods that always worked in the past, have been ineffective. Why should we expect some secret weapon to do the trick now? The fact is that Chairman Bernanke does not expect to unveil any such weapon. In the second part of his speech, he points to the real hope for improvement.

As I mentioned earlier, this second part of the speech has been more thoroughly analyzed. In it, Bernanke tells Congress very clearly that the ball is in their court. "Without significant policy changes, the finances of the federal government will inevitably spiral out of control." That's laying it on the line. Bernanke becomes more circumspect, however, when he explains what needs to happen and how it needs to be done. He says, "Although the issue of fiscal sustainability must urgently be addressed, fiscal policymakers should not, as a consequence, disregard the fragility of the current economic recovery." The repetition of the word "fiscal" is important. Bernanke is emphasizing the distinction between the Fed, which makes monetary policy, and Congress, which makes fiscal policy. Second, though he does not say it in so many words, he is specifically urging the Republican majority in the House not to concentrate solely on cutting expenditures. "Fiscal policymakers can also promote stronger economic performance through the design of tax policies and spending programs." Fiscal as well as monetary stimulus is necessary to propel the recovery forward. Rigid austerity programs, like the policies instituted by Prime Minister David Cameron in Great Britain, are not the answer.

Bernanke's last point is that "the country would be well served by a better process for making fiscal decisions." Like the President, Bernanke is calling on our elected representatives to act like grown-ups. But I think he is saying something more substantive. Bernanke must be comparing the Fed's well-organized, civil, and effective decision-making process with the pitiful spectacle that Congress made of itself this summer. What a mess monetary policy would be in if it were conducted like fiscal policy! Come on Congress, look at how the Fed does it and try to be like them. The Governors of the Fed have widely differing opinions and political backgrounds, just like you. But they make rational and timely decisions. Why can't you?

Recommended Reading

David Deutsch: The Beginning of Infinity: Explanations That Transform the WorldWith the possible exception of Ray Kurzweil's The Singularity Is Near, this is the most optimistic book I have ever read. If you choose to read the book, you will understand, among much else, what optimism really is. But, I have to warn you, the book is long and very difficult, being a combination of quantum physics and philosophy. I would not suggest it, if I didn't think it was extremely important, and, especially for younger persons, life-changing and life-affirming in the best senses of those over-used terms.

Liaquat Ahamed: Lords of Finance: The Bankers Who Broke the WorldThis a must-read for anyone interested in history and economics. Ahamed's history is sound and his analysis of how people--even experts--really make economic decisions is exactly on the mark.